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March 12, 2013

Why Bogle Is Dead Wrong on ETFs

The Vanguard founder employs data to defend his dislike of ETFs, which ETFGuide’s DeLegge asserts is contrary to evidence

Editor’s Note:Research Magazine and AdvisorOne contributor Ron DeLegge published (originally on ETFGuide) a strongly worded critique of Vanguard founder John Bogle’s dim view of ETFs, found below. The letter provoked an equally robust reply from Bogle. DeLegge tells AdvisorOne he plans a further response to Bogle’s rebuttal.

Everyone has heard about love at first sight. But what about hate at first sight? The latter describes John Bogle’s long-lasting hate affair with exchange-traded funds (ETFs).

Mr. Bogle is a well-known figure. He’s the founder and retired CEO of the Vanguard Group, which manages around $2 trillion in assets. He’s also the man who launched the first retail index mutual fund in the U.S. back in 1975.

But he can’t—or doesn’t want to—understand ETFs.

I know this firsthand, because I’ve had the privilege of interviewing Bogle several times on my weekly radio program. And in every single instance, he’s made it a point to demonize ETFs—even broadly diversified ones with expense ratios lower than index mutual funds.

In a series of excellent interviews with Matt Nesto of Yahoo! Finance, Bogle once again took aim at ETFs, saying “they’re no way to invest.” Let’s analyze a few key points of why John Bogle is dead wrong about the ETFs.

Bogle’s Folly?

A 2012 research piece from Vanguard itself refutes Bogle’s theory that ETFs are converting the investing public into day traders.

Joel Dickson, one of the study's authors and a principal in the Vanguard Investment Strategy Group, said, "Our individual investor data show that the majority of both traditional mutual fund and ETF investments are held in a prudent, buy-and-hold manner.”

The study, titled “ETFs: For the Better or Bettor?” analyzed more than 3.2 million transactions in more than 500,000 positions held in traditional mutual fund and ETF share classes of four different Vanguard index funds from 2007 through 2011.

Why does Bogle conveniently ignore Vanguard’s very own ETF research whenever he discusses ETFs? Is it because the data disagrees with his hyper-radical views? Or is it because the analysis on 3.2 million accounts is not adequately rigorous?

ETFs ‘Tempt People to Trade’

Among Bogle’s chief contentions against ETFs is that they tempt people to trade, therefore, they shouldn't exist. The same faulty reasoning probably applies to other areas of life.

For example, what about modern-day transportation? Should we return to the era of horses and buggies because people are tempted to drive too fast? Who’s causing all of these automobile accidents, anyway? Is it cars? Or is it drivers? Only a cave person with a prehistoric mentality would blame the misapplication of clear-cut advancements like automobiles and ETFs on the products themselves versus error-prone individuals.

The fact that ETFs offer intraday liquidity is not a design flaw. What’s wrong with the transparency of letting people buy or sell at real-time market prices versus unknown net asset value prices? Isn’t locking up customers’ money in a mutual fund until the end of the day the real tyranny?

Trading Volume

Bogle says the turnover rate (or buying and selling) of popular ETFs like the SPDR S&P 500 (SPY) tops 5,000% in some cases. But what he omits in his rants is that buy-and-hold ETF investors are not adversely impacted by any of this. That’s because ETF shareholders are not liable (tax-wise and commission-wise) for the trading activity of their follower shareholders. By the way, that’s not necessarily true of the mutual funds that Bogle defends to the death.

What about all of that evil trading volume?

The very trading volume that Bogle demonizes, in fact, allows for market participants to successfully execute both sides of the trade. Think about it this way: What kind of chaos would be caused by a John Bogle type of stock market of all buyers and no sellers? Is that the kind of place you’d like to invest? Thankfully, the ETF marketplace doesn’t operate that way. Nor should it.

Bogle’s Bias

“An ETF is like handing an arsonist a match” was something Bogle said way back in 2001. Incidentally, that was the same year that Vanguard launched its first series of ETFs like the Vanguard Extended Market ETF (VXF) and the Vanguard Total Stock Market ETF (VTI). Like other Vanguard ETFs, the funds operate as an additional share class of existing mutual funds.

Instead of embracing Vanguard’s foray into the ETF market, Bogle strongly resisted. And he still resists today. Meanwhile, the growth of the ETF industry has seemingly passed him by, zooming ahead from a few hundred million in assets to $1.4 trillion today.

In an admission, Bogle told Yahoo Finance, "The growth has been much more than I would have ever expected." That’s a huge understatement.

It’s fair to say that Vanguard wouldn’t have $250 billion in ETF assets if Bogle was still running the company. Thankfully, someone at Vanguard had enough sense to avoid steering the company into the same abyss as mutual fund companies still holding with a firm grip a dying legacy.

Whether he acknowledges it or not, ETFs are an extension of the index investing philosophy Bogle started back in the 1970s. And regardless of what he or anybody else thinks, the next phase of growth for ETFs will be inside 401(k) plans.

None of this changes Bogle’s status as a kind of Paul Revere to the investment world, particularly individual investors. Even with age, he’s still articulate and relentless in his fight against Wall Street's selling machine. And tossed into that mix are his irrational arguments against ETF investing.

And through it all, it’s still hard to dislike John Bogle. Even when he’s dead wrong.